Editor’s note: This market commentary is provided by Dave Kurzawski and Eric Meyer, risk-management consultants with FC Stone/Downes-O’Neill, Chicago, Ill.

Class III prices settled mixed and well-supported after a day that could have easily brought about a 20-30 cent price decline in the past.  From a technical perspective, futures prices appear strong and willing to take out certain levels of resistance as it has done over the past week or so.  But with CME spot block and barrel cheese prices edging only slightly higher – falling short of the $1.50 mark – without any selling to keep a lid on prices, yesterday would seem to be an ideal day to reconcile the large gap between current spot and nearby futures prices.  As it stands, August and September are running a 9 to 13 cent cheese price equivalent premium to spot.  Moreover, CWT announced that they will remove a mere 34,000 head in this latest round of their herd retirement program.  For those who expected bullish news out of the CWT, the removal of 34,000 head is like expecting a steak and getting tofu. 

So, why were prices well supported?

Perhaps we have the newest member of the dairy complex to thank for that.  Cash-settled cheese futures are carrying a similar premium to spot, perhaps giving fodder to current Class III prices.  Or another way to look at the CME spot market is that buyers actually want to procure product as opposed to simply running the prices up.  When discussions of inventory come up, everyone seems to lean on the fact that over a billion pounds of cheese remain in storage.  The market has known that fact for some time.  Is it possible that components are down?  Is it possible that production of fresh cheese is getting a little tight?  Is it possible that demand is better than we thought?   Until proven wrong, futures prices suggest the answer to some of these questions is “yes”.

A customer of ours asked us about the topic of open interest we wrote about yesterday.  While there are several aspects to look at when studying open interest in a market, what we alluded to was that price movement, trading volume and open interest changes act as a barometer in determining the strength of a futures price direction.  Should futures rise on heavy trading volume and a material jump in open interest, then the direction of the market is seen to be on solid footing.  The same works in reverse as prices fall on heavy volume and a large increase in open interest.  Currently, open interest has been growing only slightly every day.  Perhaps this is a function of summer doldrums and low trading interest.  Or perhaps it is due to the skepticism traders have regarding a sustained rally in cheese and milk prices.  We think the latter.

CME released their weekly butter stocks report yesterday showing continued net out-movement of product at a healthy clip.   For the week ending July 3, 50.954 million pounds were reported in storage, down 3.955 million pounds from the previous week.   While not as sharp a weekly decline as the previous draw down of 8.9 million pounds (nearly 14 percent), this did represent a decline of 7.2 percent vs. the previous week.   More importantly, the current amount of butter in CME approved warehouses is down 50 percent vs. last year.  We find this fairly supportive for butter prices as the last time year over year declines eclipsed 40 percent in July was in 2004.

Corn prices rebounded yesterday removing nearly all of Tuesday’s losses but stopped short of key areas of trading resistance ($3.91 in December).  We believe that a top on corn prices is still in place and that poorer than expected weekly crop ratings (particularly for soybeans) and strong outside markets had a hand in yesterday’s rally.  While corn growing weather over the next three weeks is critical, it’s like a greenhouse for most of the Midwest right now.  We expect that weather will trump other news and keep a lid on grain prices today.   If you need to sell corn, we think the $4.00/bu market for 2011 is a place to get some sold.  We will wait on buying for end-users today.

http://www.cmegroup.com/daily_bulletin/Section04_Agricultural_Soft_AltInvestment_Futures_2010129.pdf

7/7  Class III Futures:   Volume:  1191  Open Interest (OI) Change:  +150  Total OI:  25,991

7/7  Class III Options:   Est. Put Volume:  334   Total OI:  18,635   Est. Call Volume:  187  Total OI:  17,351

7/7  Spot Markets:   Block Cheese $1.48 (UP 1/2),  Barrel Cheese $1.4625 (UP 1 1/4),  Butter $1.75 (UNCH),  NFDM: A $1.21 (UNCH),  X $1.23  (UNCH)

7/7  Other Dairy Futures Volume:   Butter:  41   Dry Whey:  25   NFDM: 6    Class IV:  0   CHEESE:  15

7/7 Individual Cheese Futures Prices, Change, Volume & Open Interest
Jul           $1.43      UNCH                   Vol:   0                      OI Change:  UNCH
Aug         $1.55       UP .024                 Vol:    1                     OI Change:  UNCH
Sep         $1.60      UP .019                  Vol:   8                     OI Change:  DOWN 1
Oct          $1.587     UP .004                 Vol:  5                     OI Change:  DOWN 4
Nov         $1.569     UP .007                 Vol:  0                     OI Change:  UNCH
Dec         $1.566      UNCH                  Vol:   1                    OI Change:  DOWN 1

7/7 Individual Class III Futures Prices, Change, Volume & Open Interest
Jul           $13.50    DOWN 1              Vol:  39                  OI Change:    DOWN 6
Aug         $14.63    UP 1                      Vol:  727                OI Change:    UP 92
Sep         $15.00    UNCH                   Vol:  174                OI Change:   UP 18
Oct          $15.00    UP 3                      Vol:  101                OI Change:   DOWN 26
Nov         $14.72    DOWN 6               Vol:  31                 OI Change:   UP 13
Dec         $14.69    DOWN 3               Vol:  51                 OI Change:   UP 18
Aug-Dec 2010 Avg:  $14.81                                          DOWN 0.01/cwt
Jan-Dec 2011 Avg:  $14.56                                           DOWN 0.01/cwt

Source:   FCStone/Downes-O'Neill